Rule of 72

Have you ever been disappointed with one of your investments? If so, it may be that you were fed the wrong expectations. At Wealthpoint we believe that investors should be accurately informed and well-educated. Unfortunately, too many investors wake up one day and realize there is a discrepancy between what they were told would happen with their investments, and what actually happened.

That’s why we’d like to give you a tool you can use to quickly find out if you’ve been misled by somebody you trusted with your money.

It’s called the rule of 72. The rule of 72 simply means that if you want to know how many years it will take for your asset to double in value, divide the number 72 by the average return you expect from the asset.

For example, suppose an asset is supposed to return an average of 6%. 72 divided by six is 12. Therefore it should take 12 years for the asset to double in value.

If an asset is supposed to return an average of 10%, you divide 72 by 10 and get 7.2 years.

Consider your own assets. What average return did you expect from them? Divide 72 by that number, and you’ll find out how many years it should take for your money to double.

Are you on track? Ahead? Behind?

Most investors find that they are behind… far behind. One cause for this discrepancy is that whenever an asset loses value, it takes a correspondingly greater gain to make up the entire loss.

For example, let’s say stock ABC is trading at $100 per share. It falls 20%, to $80 per share. How many percentage points will it take for ABC to return to trading at $100 per share?

You may think a 20% gain will do the job. But 20% of $80 is $16, and $80 + $16 is only $96. If your asset loses 20% one year, and gains 20% the next, its average return for those two years is 0%. Yet it lost $4 in value!

Anytime your asset has a down year, you experience a lower return than the Rule of 72 indicates you should enjoy. The more you can eliminate the frequency of down years, the closer you can come to matching the Rule of 72.